The Conundrum of Zero APR: An Analytical Framework
Abstract: We document the prevalence of promotional pricing of credit card debt in the U.S. and develop an analytic framework to study how interest rates on multiperiod credit line contracts should be set when debt is unsecured and defaultable. We show that according to the basic theory of unsecured credit — suitably extended to allow for promotions — interest rates should price in the expected default risk on a period-by-period basis. The inspection of our model’s mechanism implies that time-consistent consumption behavior is crucial for this result; accordingly, modeling time-inconsistent consumption behavior can be one means of rationalizing promotions — as we also discuss.
Keywords: zero APR; credit cards; promotional introductory offers; unsecured debt;
JEL Classification: E21; D91; G20;
File(s): File format is application/pdf https://www.philadelphiafed.org/-/media/frbp/assets/working-papers/2023/wp23-06.pdf
Provider: Federal Reserve Bank of Philadelphia
Part of Series: Working Papers
Publication Date: 2023-03-13